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The Fed Should Not Regulate Bankers’ Compensation

The Federal Reserve Bank (Fed) has proposed a plan to regulate the pay of bank employees by allowing the Fed to reject compensation schemes it views would encourage excessively risky behavior. Regardless of whether one thinks bankers’ compensation should be regulated, the Fed should not be doing this.

The Fed’s major responsibility is controlling the size of the money supply, which determines interest rates and the amount of inflation in the economy. It does so with almost no oversight, but fortunately, its control over the money supply attracts relatively little political attention, most likely because few Americans actually understand what the Fed does.

The effects of its control over the money supply are relatively neutral, in that the entire economy feels the same effects, so the Fed is, for the most part, not balancing diverse interests. While some people may want lower interest rates and others want them higher, the longer-run goal of price level stability tends to pull diverse interests toward the same policy page. The lack of oversight is not as big a problem when everyone shares common goals and when the Fed is viewed as a neutral administrator of monetary policy.

The Fed’s oversight of monetary policy is an important job: one we may take for granted when we have a prolonged period of relative price level stability, but we only need look back to the 1970s to see what happens when the Fed’s attention is divided between price level stability and other policy goals. To add to this responsibility an inherently politicized power to regulate bankers’ compensation would tarnish the Fed’s appearance of neutrality and embroil it in political controversy.

To give this power to the Fed would politicize the Fed and would compromise its ability to administer monetary policy in a manner relatively detached from political pressures. Even if one thinks bankers’ compensation should be regulated (I don’t but that’s irrelevant to my argument here), the Fed is not the right organization for this job.